Want to Stash Cash? Try Alaska and Nevada

When people think of tax havens, they usually picture the Swiss Alps or Caribbean islands.

But traditional venues like Switzerland, the duchies of Lichtenstein and Luxembourg and Caribbean paradises like the British Virgin Islands are finding competition from the U.S., where lawyers in seven states, such as Nevada and Alaska, are muscling in, looking to grab business from the world's wealthy.

They're peddling the concept of a "self-settled spendthrift trust," an irrevocable trust that is created by its beneficiary and is designed to preserve wealth. A consequence of that is that these trusts can help shield assets from lawsuits or creditors.

Contrary to the popular vision of "offshore" banking, the true purpose of these accounts for many wealthy clients is to protect a lifetime of earnings and savings not from being taxed, but from being wiped out in a major lawsuit--say, a medical malpractice or a class-action securities litigation against an executive.

"Litigation is a much bigger threat than taxes because there's an unlimited amount of assets at risk," says California lawyer Jeffrey Verdon. "High-net-worth people are at bigger risk than normal people."

There are other strategic reasons. Offshore companies in the British Virgin Islands, for example, can be used to house estate assets that can be passed to family members without estate taxes.

And offshore accounts can open doors to new investment opportunities. Offshore investment funds not registered with the U.S. Securities and Exchange Commission often require U.S.-based investors to set up an offshore entity to participate.

Of course there is the, ahem, possibility that the accounts are being used to avoid paying excessive taxes, even though U.S. taxpayers who have offshore accounts are required to file annual forms to the U.S. Internal Revenue Service detailing transfers and other trust activities--or face a penalty of 5% of the value of the assets. They are also supposed to file forms detailing distributions from their trust (or face a penalty of 35%).

Some countries don't necessarily enforce the reporting requirements, and some, like Luxembourg, say it's up to the trust owner to keep up with the paperwork.

This perpetuates the notion that offshore accounts are being used to scam the government. "Offshore holdings continue to be viewed with skepticism and a presumption of impropriety by the IRS," writes Jeffrey Morse, a Las Vegas lawyer, in the March issue of Nevada Lawyer magazine.

Perhaps for that reason, "offshoring" has acquired a bad name. There has been a push internationally to rein in what countries can offer foreigners looking to park assets. Earlier this year, German tax authorities raided Lichtenstein, and the scandal involved spies hired by the German government to investigate what German citizens were doing with their money there.

Maybe that's why there is a movement to put assets in U.S. accounts. U.S. trusts are less costly to set up and have less paperwork hassle than some offshore locations. They are available in Alaska, Delaware, Nevada, Oklahoma, South Dakota, Rhode Island and Utah.

Still, there is reason to pause before diving in. For starters, there isn't enough case law in the U.S. to judge whether the onshore trust will shield assets for those who don't actually live in the state where they were formed.

For another, there's a reason why other states haven't climbed on board. As a basic public policy, it makes little sense to encourage individuals to hide or keep out of reach assets from their creditors or others, such as angry ex-spouses.

And U.S. trusts don't necessarily make it impossible for creditors to go after assets. Where a creditor might be deterred by the expense and hassle of pursuing assets held offshore, that isn't necessarily the case at home.

In Nevada, for example, the law expressly forbids the funding of a trust to hinder, delay or defraud known creditors. If a creditor had a claim on the assets before they were transferred into the trust, the creditor has up to two and a half years to get a judgment in its favor. If the creditor's claim comes after the transfer of assets, it's out of luck after two years.

Of course, that is the case of offshore trusts, too, especially where a spouse is involved. In a recent New York court case, part of a husband's assets were offshore in trust in the Cook Islands--but only part, about half.

A judge ruled in the divorce that the husband could keep his assets in the Cook Islands, but he had to fork over the rest to his wife.

"Too many people try to play games with them," says Chris Riser, a lawyer at Riser Adkisson LLP. "Make them something they're not." Caveat emptor.